Identifying long-term trends can be tough in commodities

When commodity prices are high, everybody wants to talk about them.

But now that they’re back in a more typical grind of low values and marginal returns, it has grown quiet.

“The amount of consulting work offers I get now have completely dried up,” David Jacks, an economist with Simon Fraser University, said with a laugh.

“That’s a pretty clear indication that the euphoria (is over).”

But for Jacks, his observations about commodity markets over the long run have been borne out by what he has seen since 2011, when the world was still in the grips of the biggest commodity bull market since the 1970s: booms and busts can take prices far above or below long-term trends, and there can be extended periods of higher-than-trend or lower-than-trend prices, but in the end the trends reappear.

For crop prices, that isn’t great news for producers.

“This is a lower-for-longer type story,” said Jacks in an interview.

Since the end of the Second World War, crop prices have trended downward in real, inflation-adjusted terms, while other commodity classes including metals and meats, have trended higher.

Regardless of sometimes significant deviations from the trend, the ever-lower per tonne trend for crop prices reappears. However, that can be hard to see for people when they are living in the midst of multi-year deviations, like the 2006-13 bull market in crops, and the 2000-14 overall commodities bull market.

“People were confusing this cyclical component for an underlying trend,” said Jacks, who was first commissioned by a hedge fund in 2011 to analyze long-term commodity price behaviour and then updated his analysis in subsequent public research articles.

“Long-run patterns can be easy to miss if we confuse cycles for trends,” said Jacks.

The complexity of commodity price patterns is broken apart in Jacks’ 2017 paper, From Boom to Bust: A Typology of Real Commodity Prices in the Long Run. It reveals how long-term trends can be hard to see during periods of above- and below-trend prices, and especially in the sporadic spikes and slumps that can stun markets for a year.

The period from 1998 to today is an example of this, with below-trend prices reversing into above-trend prices and then settling back closer to the long-term trend.

“Much of the recent appreciation of real commodity prices simply represents a recovery from their multi-year, and in some cases multi-decade, nadir around the year 2000,” writes Jacks.

Prices since the mid-2010s don’t seem low to Jacks in long-term terms.

Where do the multi-year surges in prices come from? Jacks sees their origin and lasting power in “demand shocks” that occasionally arise, such as with the industrialization and urbanization of the United States in the early 20th century, in the recovery of Europe and Japan after the Second World War, and with the dramatic rise of China recently.

Farmers hoping to see another multi-year bull market in crop prices will probably need another demand shock to propel it.

“If there’s going to be any kind of recovery from these kind of lows that we’re seeing right now, you really do need that demand shock coming online,” he said.

“You need that big demand shock, and there’s really nothing online that we can see at this point.”

That doesn’t mean prices can’t temporarily surge, but those spikes are likely to be shorter-lived than multi-year bull cycles driven by a persistent demand shock.

Over 100 years of commodity market history, the spikes and slumps from trends tend to last about one year.

Jacks sympathizes with people who think they’re seeing long-term trends when they look back 10 or 15 years and see something that seems evident. The bullishness of the early 2010s came from years of high prices.

“There was a lot of talk about a ‘new normal.’ Commodity prices were at record highs and they weren’t going down from there,” recalled Jacks.

However, standing back with more historical perspective, those few years of high prices were just a “cyclical component” that didn’t negate the long-term trend, and unfortunately people were “thinking that’s actually the trend.”

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